Aug 4, 2009
Executives
Gabi Seligsohn – President and Chief Executive Officer Dror David – Chief Financial Officer
Analysts
Robert Katz – Senvest Capital, Inc. Neal Goldman – Goldman Capital Management
Operator
Welcome to the Nova Measuring Instruments' second quarter 2009 earnings conference call. (Operator Instructions).
I would like to remind everyone that forward-looking statements for the respective company's business, financial condition and results of its operations are subject to risks and uncertainties that could cause actual results to differ materially from those contemplated. Such forward-looking statements include, but are not limited to, product demand, pricing, market acceptance, changing economic conditions, risks and product technology development and the effect of the company's accountancy policies, as well as certain other risk factors which are detailed from time to time in the company's filings with the various security authorities.
If you have not received a copy of today's press release and would like to do so, please call GK Investor Relations at 1-866-704-6710. With us online today are Mr.
Gabi Seligsohn, President and CEO of Nova, and Mr. Dror David, CFO.
I would now like to hand over the call over to Mr. Gabi Seligsohn.
Mr. Seligsohn, would you like to go ahead?
Gabi Seligsohn
Welcome to our second quarter of 2009 earnings conference call. The second quarter of 2009 marked a momentous change for the company on all fronts.
From the product side we gained impressive recognition for our standalone optical CD product line having received all time record orders from several leading customers. Through orders received during the second quarter we have evidence of significant increase in our market share in both the standalone and integrated metrology sectors serving high-end memory and foundry customers as they migrate to more aggressive design rules.
On the financial side we were able to rebalance the operation and show break-even numbers with very impressive improvement to our gross margins, bringing us back to the more normal levels of above 40%. Given the way the second quarter ended, and in light of the continued strength in orders evidenced during the first month of the third quarter, it is clear to us that the second half of the year will be stronger than the first after several quarters of decline.
Having recently visited our key customers in Asia-Pacific, Japan and the U.S., I got a common theme from all. Their focus is clearly on rapidly migrating to the next technology node by utilizing as much of their existing capacity as possible in order to control costs.
Our combination of standalone and integrated metrology products provide them with a cost effective means to extend the life of existing process tools and tighten their performance with advanced process control solutions. Now to give you some more and additional insight, let me review what happened during the quarter.
As mentioned in our May conference call we continue to see utilization rates at key customers' sites rapidly climbing to above 90%, most at the high-end. This immediately led to improvements on the service side of the business with repairs held off for months being pulled in for immediate installation.
Dror will provide more insight on this front during his prepared commentary. After years of expectations, the high-end memory sector is finally migrating to copper as its choice of material for inter-connect layers.
Both high-end NAND flash customers as well high-end DRAM customers are adding a couple of layers of copper. Right after the end of the quarter we announced that two major flash manufacturers have decided to deploy our integrative metrology product on their CMP polishers and that by doing so they were able to tighten their process performance by 30%.
This adds to the success we have recently enjoyed in the area of copper at major foundries where both our integrated and standalone products are utilized in conjunction with one another to improve yield. During the second quarter we also announced an additional capability for our NovaMARS modeling software which provides a revolutionary solution for one of the key challenges of optical CD measurements, namely material characterization on pattern structures on the wafer itself.
This capability was at the center of a joint publication made with IBM and Global Foundries earlier this year. Later, during the month of July, NovaMARS received the Product of the Year award from Semiconductor International magazine, an honor bestowed on companies who win the vote of leading customers.
Through a focused effort made by the management team we were able to selectively cut expenses over the last several quarters, carefully making sure our product development and customer support efforts remain intact. Though second quarter revenues were 37% lower than the parallel quarter last year, we were still able to bring an impressive improvement to our gross margins, taking them from 39% to 41%, respectively.
Looking at the extent and type of customer interactions of the last few months it is clear to us that our product strategy has proved right. Our unique ability to provide fully matched integrated and standalone metrology products with highest reliability, highest throughput and shortened time to solution make us a very attractive choice for our customers.
Through these customer interactions we have widened our reach in the fab to several more areas of manufacturing and development, allowing us to broaden our addressable markets. During the protracted downturn we worked closely with leading edge customers on developing their next technology node with our products embedded.
Now that these customers are moving forward with their new products we are capitalizing on that joint development work and enjoying a significant increase in orders. Now let me turn to the industry outlook as we see it.
Several months ago our industry experienced an almost complete halt in business. Fabs which were battered by the steep decline in business fundamentals, took defensive measures and decided to cut all spending to below maintenance levels.
It was towards the end of the first quarter of this year that we, as well as our peers, started to see an increase in business. So far, from what we have seen and heard from our customers, all spending is focused on transitioning existing fab capacity to be able to deal with more advanced technology nodes.
While this implies a reduced level of overall wafer fab equipment purchases given the lack of new fabs being opened, the selective nature of spending creates a unique opportunity for Nova on both of our product fronts. On the integrative metrology side customers can retrofit existing process tools which were purchased for 65 nanometer technology and extend their capability down to 45 and 32 nanometers by measuring all wafers and adjusting process parameters on a wafer-by-wafer basis.
They do this in order to meet tighter process window requirements. This is done on layers which are considered critical.
On the less critical layers customers can elect to use our standalone product and sample three to five wafers out of every batch of 25, which still allows them sufficient information to be able to adjust the process on a less frequent basis. Another interesting trend we are seeing is that customers are upgrading older generation Nova tools to later models and with optical CD software.
With an active install base of over 500 300-millimeter tools upgrades are becoming an interesting opportunity as well. Given the revitalized increase in computer spending we have recently seen a significant amount of orders from hard disk manufacturing facilities as well.
With the continued technological advances in the hard disk space and the competition it faces with solid state drive technology, more process monitoring control has become necessary. Finally, our addressable markets are also growing.
We are now seeing a proliferation of our technology into more areas of the fab beyond our traditional CMP applications. Given the capability of optical CDs to perform multiple layer analysis, we can now provide process visualization in lithography, etch, CVD and CMP areas.
Our more advanced customers are feeding this information forward and backward to provide even tighter process control across the fab. Looking into the remainder of the year and as mentioned in today's press release, the significant increase in bookings will lead to stronger financial results in the second half of 2009.
And with that I would like to turn it over to Dror for a closer look at the numbers. Dror?
Dror David
As Gabi mentioned we are very pleased with our financial performance in the quarter, which showed significant progress in all important elements. Revenue-wise we have seen 22% increase quarter-over-quarter, $7 million in Q2 relative to $5.7 million in Q1.
The increasing quarterly revenue is related mainly to our market share gains in the optical CD standalone segment as well as to a slight, yet encouraging, improvement in revenues from services. As stated in our May earnings call, the larger portion of the second quarter bookings was not yet delivered or recognized within the second quarter, and we expect it to be delivered and recognized in the third quarter of the year.
Looking at sales by territory product revenues in the quarter continue to come from the East with Asia-Pacific practically accounting for all of our product revenues during the quarters. Looking forward based on our end quarter backlog we expect the U.S.
and Japan to start coming back as well. On the product revenue side following standalone sales becoming a more significant portion of our revenues, we have witnessed a significant increase in the overall ever [turning] prices.
This enabled us to maintain our product gross margins at the 56% levels similar to the previous quarter. On the service side, we were happy to see a 12% increase in revenues.
Service contract revenues continue to decline in the quarter yet were more than compensated by time and materials revenues. In addition, in light of the fact that we further reduced our global service costs by an additional 9%, we were able to show major improvement in service gross margins quarter-over-quarter, from negative 10% in the first quarter to positive 10% in the second quarter.
It is important to note that the [pilot] to this improved financial performance we have continued to maintain our on-site presence at strategic customer sites in order to facilitate continued successful penetrations into these customers. Actually, we also received supplier service awards from two of these strategic customers in recent months.
Looking at our overall gross margin performance, blended gross margins in the second quarter were 41%, a major improvement relative to the 33% gross margins in the first quarter of the year and also better than the 39% gross margins in the comparable quarter of last year. During the second quarter we reduced operating expenses by additional [14%].
The majority of this decline was driven by the decrease in our net research and development expenses related mainly to higher income from the office of the chief scientist during the quarter due to final approvals of yearly programs. Gross research and development expenses remained stable during the quarter relative to the previous one, and demonstrate our decision to continue to aggressively invest in product development program.
In terms of bottom line, the company reported breakeven results with a slightly positive net result on a non-GAAP basis. Cash flow-wise as we communicated in the Q1 conference call, we still saw a negative operating cash flow of $2.1 million in the quarter, which is an improvement of $1.5 million from the previous quarter.
Most of the cash used for operating activity during the quarter was related to the increasing accounts receivables due to the increase in revenues during the quarter. Overall cash reserves at the end of the second quarter were $14.2 million.
As Gabi mentioned, looking into the second half of the year, we expect that the backlog we had entering into the third quarter and the booking [fetters] at the beginning of the third quarter and to date will drive further improvement in our financial performance. We believe we have crossed the bottom of the cycle and we plan to continue our fiscal discipline in [part] to our technological and penetration advancement.
Gabi?
Gabi Seligsohn
Thank you Dror, and with that, operator, we'd be happy to take some questions.
Operator
(Operator Instructions). Our first question comes from Robert Katz – Senvest Capital, Inc.
Robert Katz – Senvest Capital, Inc.
I have a few questions. For starters, what is your expectations for R&D going forward?
Was this a one-time event with the Office of Chief Scientists?
Dror David
Yes, this is related to final approval of programs which happened in May, so we expect next quarter the income from the chief scientist to become more normal which should add to the net research and development expenses around $400,000 a quarter.
Gabi Seligsohn
In general, as you know, Robert, these are yearly programs that we've been very effective at getting the assistance of the Office of the Chief Scientist, so this is something that's somewhere around these numbers on an annual basis, so yes.
Robert Katz – Senvest Capital, Inc.
Right, and what was the book-to-bill for the quarter?
Gabi Seligsohn
We don't want to say specific numbers but it was significantly above one.
Robert Katz – Senvest Capital, Inc.
And how many standalone units did you ship and recognize? Well, how many did you ship and how many did you recognize in that quarter?
Gabi Seligsohn
Again, we're not going to talk specific numbers on how many we shipped and recognized, but I will say that most of the shipments, or actually most of the recognition for the orders received, will take place in the third quarter. So what you saw is the smaller portion in the second quarter.
The larger portion will happen in the third quarter.
Robert Katz – Senvest Capital, Inc.
And with non-standalone revenue, how much came from [inspirated] that was sold really the OEM and how much is through direct sales now?
Gabi Seligsohn
I'll say this. In general what we're seeing is a trend more towards direct selling to end users in the last two quarters.
The reason is that, as I mentioned in my commentary, a lot of the business now on the integrated front is retrofit business of two types. One is a situation in which there is Nova tool integrated on an existing process tool, and then the customer buys a brand new tool and integrates it onto an existing tool.
In that case there has been a preference to buy that directly from us. There are also cases in which it's an existing older version of a Nova tool and yet again they want to upgrade to a later version, so most of the business we're seeing these days is actually retrofit business.
They are the – obviously the equipment sector is still alive, even though we have seen reductions in the amounts in process tools versus previous years. So there are situations in which brand new tools are shipping, and in those situations in most cases it's sold with the OEM themselves for now.
But I think in general this has been generally an improved business model for us and I think that this trend will continue. I think that the business relationships exist such with both the OEMs and the end users that this is something that has proven to be successful for everyone.
Robert Katz – Senvest Capital, Inc.
Great, and how many customers do you now have for the standalone?
Gabi Seligsohn
By now we have 10 customers.
Gabi Seligsohn
How does that compare to last quarter?
Gabi Seligsohn
Compared to last quarter, we added one customer in the last quarter.
Robert Katz – Senvest Capital, Inc.
And that was the announced customer, or was that a different customer?
Gabi Seligsohn
It was a combination but yes, it was one addition of a new customer. I think that the biggest thing that's happening is the extent of deployment now because we started this process of penetration a while ago.
And the big success and the reason for the press release in the quarter itself for record quarter for standalones was mostly associated with turning already existing penetrations into multiple tool orders, and that's really the big story. Having said that, it's critical also, that we added another customer in the quarter which brings it all together to 10 customers.
Robert Katz – Senvest Capital, Inc.
Right, and in terms of numbers, you mentioned quite a few processes you now address within the fab, what would your dollar content per, let's say, 10,000 wafer starts be? Is that a way to look at this?
Gabi Seligsohn
I'll try to help a little bit. As you can imagine as frequently is the case, it's customer specific.
Foundries behave differently from memory customers. Memory also is not just one type of memory.
It also depends on the process stability or instability that a customer is suffering. So you can see a variability there, but what you will also factor in is seeing such as the extent of deployment of optical CD technology.
Some customers are very aggressively deploying it, and therefore displacing tools such as CD send tools, or opaque film thickness tools and things of that nature. So it really depends on the specific customer.
I will say that some customers will take a standalone tool for every – I don't know, 3,000 to 5,000 wafer starts so we'll take a little bit more than that, if that gives you some indication.
Robert Katz – Senvest Capital, Inc.
Yes. And if you look at last cycle, your revenues peaked, the product revenues peaked around, was it $13 million roughly?
Gabi Seligsohn
Last year you mean?
Robert Katz – Senvest Capital, Inc.
In '07.
Gabi Seligsohn
'07 was $16 million in Q4.
Robert Katz – Senvest Capital, Inc.
Q4 and of that $13 million was product-related.
Gabi Seligsohn
Right. Correct.
Robert Katz – Senvest Capital, Inc.
And you address a much smaller ham, I guess. In this cycle what do you think in terms of multiple of that market size do you think you address now?
Gabi Seligsohn
Well, it's an interesting question because there's two ways to address it. On the one hand, as you know, wafer fab equipment has declined very significantly.
I mean this year, Gartner is saying it's $8 billion to $10 billion and most of our peers are agreeing. We also tend to agree that in '07 it was $32 billion, so that's one thing to remember, right, that the overall market has contracted very significantly.
Having said that, when I look at addressable market and leave alone millions of dollars for a moment and just say what areas that we're addressing, we're definitely addressing a much wider market opportunity, right? We're addressing and we are displacing, as I said, in many cases a tool such as CD-SEM, which in a good year like 2007 was a $350 million to $400 million market.
The metal thickness measurement tools are set to be anywhere between $50 million and $100 million dollar markets in 2007. Integrated metrology that year was about 80, so this year I mean we have the forecast that we got from people like Gartner.
It's very difficult because things have changed during the year, to say how big the market's going to be. The way I like to look at it right now is to look at addressable markets and see how much of those we really cover with our technology footprint.
And I do know one thing, that these are growing segments because optical CD technology is being deployed very aggressively. It's taking more and more layers into fab because it's useful.
It's very high throughput. It's non-destructive.
The cost of ownership is very attractive as well, so I see that the technology actually is going to lead to extended deployment and as I gave these examples there will be more areas in the fab being covered by this technology. The other thing that's happening as I mentioned is the migration to copper inter-connect and the memory, which everyone thought was going to happen a little bit earlier on.
It's really starting to happen right now and again, this lays foundation for a wider market opportunity for these tools. So I think that in general overall addressable markets are going to grow.
I think that, and again, as I mentioned in my prepared comments, process control in general as a segment is going to continue to outgrow process equipment and actually in this financial situation in which it's scarcely the case that new fabs are being built, the portion of available spending going to process control, I think, is going to continue to grow. And that's what we've been seeing in the last two quarters.
Robert Katz – Senvest Capital, Inc.
And do you expect your ASPs to continue to grow on the integrated as well because of your direct strategy?
Gabi Seligsohn
It really – I think it depends on a mix that's going to take place. So it really depends on the mix and the extent of new tool proliferation versus older ones.
I think in general the trend has been a positive trend and it works actually in favor of everyone. I think the customers are quite happy with it as are the OEMs as are we.
So there's a good chance that it can continue, but the rate of it very much depends on what happens in the industry.
Robert Katz – Senvest Capital, Inc.
And is there an option to take market share on the Integrated side or would your competitors' customers basically turn to them for an upgrade of their older products?
Gabi Seligsohn
Our market share is very significant in the Integrated side and the previous cycle created a huge install base for us. One of the things we've done very effectively with the customers is work with them to continuously upgrade that install base.
So I think our product is quite competitive. I think the competition has lost quite a bit of the market share in the last couple of years.
There will always be continued attempts to take market share, but I think our product and the capabilities that we keep on launching still allow us to maintain strong technological advantage, but it's not just the technology. One of the things that we have shown and I think that's where we excel and where we carry a lot of price, is that the business model of Integrated is so unique and complicated for some other companies, that we have been able to provide an overall package which is quite attractive and Dror mentioned, for instance, the service awards that we receive is part of what the customers look at when they make their decisions on what to do next.
So we've been there with them as I mentioned in the call when they developed going from 65 to 45 in foundry or going from 80 to 50 nanometer in DRAM or going from 50 to 30 in NAND. We've been there and we continue to enjoy the incremental business, so far.
And we're not ever overly confident. We understand we need to continue to add some finality and capabilities and that's what we'll do in order to defend our market share.
Robert Katz – Senvest Capital, Inc.
Excellent, one last question, do you expect to be cash flow positive in Q3 and Q4? Or do the ramps in revenues look – continue to absorb cash and property more from capital?
Gabi Seligsohn
As we mentioned in the press release, the second half of the year looks better on all parameters, be it revenues, gross margin, profitability cash, so it looks better. For the third quarter we feel things are quite clear right now.
We feel confident that the answer is positive on the cash flow. For the fourth quarter, it's starting to shape up already.
I think we will know more within the next month and make a clear assessment for ourselves as to whether that will continue for the fourth quarter as far as the cash is concerned.
Operator
The next question is from Neil Goldman – Goldman Capital Management.
Neil Goldman – Goldman Capital Management
One question on the licensing attempts, have you set up methodology or where do we stand on that?
Gabi Seligsohn
Are you talking about IP licensing?
Neil Goldman – Goldman Capital Management
Yes.
Gabi Seligsohn
For IP licensing, we continue to look at that. There is some activity going on which is generating some interest already.
Just to remind everyone that maybe that doesn't remember, we did do IP monetization in the year of 2007 by selling a license to leading IT manufacturer. That activity in the last few months has regained some momentum.
There is nothing to report at this point in time but it is generating some interest.
Operator
(Operator Instructions). There are no more further questions at this time.
Before I ask Mr. Seligsohn to go ahead with his closing statement, I would like to remind participants that a replay of this call will be available in three hours on the company's website, www.nova.co.il.
Mr. Seligsohn, would you like to make your concluding statement?
Gabi Seligsohn
Yes, operator. Thank you.
I wanted to thank everyone for continuing to take an interest in our activities. Obviously, we're quite pleased to see the results.
And we look forward to speaking to you in the next quarter. Thank you very much.
Operator
Thank you. This concludes the Nova Measuring Instruments second quarter 2009 results conference call.
Thank you for your participation. You may go ahead and disconnect.
Operator